In re Conston, Inc.

• Decision Date: 10 May 1995
• Docket Number: Civ. A. No. 93-573 MMS.
• Parties: In re CONSTON, INC., et al., Debtors. UNITED STATES of America, Appellant, v. CONSTON, INC., et al., Appellees.
• Court: U.S. District Court — District of Delaware

181 B.R. 769 (1995)

In re CONSTON, INC., et al., Debtors.

UNITED STATES of America, Appellant, v. CONSTON, INC., et al., Appellees.

Civ. A. No. 93-573 MMS.

United States District Court, D. Delaware.

May 10, 1995.

Gregory M. Sleet, U.S. Atty., and Ellen W. Slights, Asst. U.S. Atty., U.S. Dept. of Justice, Wilmington, DE, for appellant; Gregory S. Hrebiniak, U.S. Dept. of Justice, Washington, DC, of counsel.

James L. Patton, Jr., Laura Davis Jones and David W. O'Connor of Young, Conaway, Stargatt & Taylor, Wilmington, DE, for appellees; Marvin Krasny, Michael L. Temin and Pamela A. Morone of Wolf, Block, Schorr & Solis-Cohen, Philadelphia, PA, of counsel.

OPINION

MURRAY M. SCHWARTZ, Senior District Judge.

When one travels the roads leading to the intersection of the Internal Revenue and Bankruptcy Codes, one may expect some curves. The present matter lives up to expectations! This bankruptcy appeal poses the question of whether an Internal Revenue Service claim for corporate income taxes, accorded seventh priority in a Chapter 11 reorganization case and contained in a confirmed reorganization plan, may reacquire a priority position when the debtor defaults on the Reorganization Plan and thereafter files a second Chapter 11. Pared to its core, this question implicates the meaning of "discharge" in the context of serial or sequential Chapter 11 cases and asks whether discharge causes a corporate income tax claim to lose its metaphysical nature as a tax claim when a reorganization plan is confirmed. The bankruptcy court held that the IRS tax claims became a non-priority general unsecured claims after confirmation of the debtor's plan in the initial Chapter 11 proceedings. For the reasons that follow, the Court holds that the IRS claims may qualify for priority treatment in a serial Chapter 11 proceeding, provided the claims meet the statutory requirements for priority set out in the Bankruptcy Code as measured in relation to the debtor's second Chapter 11 petition.

I. Proceedings Below

On June 20, 1990, Conston Corporation and its subsidiaries (collectively "Conston") filed their first petition for reorganization under Chapter 11 of the Bankruptcy Code in the Eastern District of Pennsylvania. Docket Item ("D.I.") 1, Exhibit ("Exh.") B at ¶ 2, Exh. C at ¶ 2. The Internal Revenue Service ("IRS") filed claims against the debtor's estate for unpaid corporate income taxes accruing during periods prior to the debtor's bankruptcy petition. These unsecured claims received seventh priority for payment by the estate pursuant to 11 U.S.C. § 507(a)(7),¹ and the reorganization plan provided for full payment of the claims as required by 11 U.S.C. § 1129(a)(9)(C).² The bankruptcy court confirmed the plan on April 18, 1991. See generally D.I. 1, Exh. B at ¶¶ 2-3, Exh. C at ¶¶ 2-3.

Conston began to operate under the reorganization plan and made several payments to the IRS. Id., Exh. B at ¶ 4, Exh. C at ¶ 4. The reorganization plan did not solve Conston's financial woes, however, and, on February 26, 1992, less than one year from the confirmation of the reorganization plan, Conston filed a new Chapter 11 petition in the bankruptcy court for the District of Delaware. D.I. 4 at 2. The present appeal stems from this second Chapter 11 petition.

In the second Chapter 11 proceeding, the IRS filed claims for unpaid portions of corporate income taxes included in the confirmed reorganization plan of the initial Chapter 11. D.I. 1, Exh. A. The IRS again asserted priority for these taxes under 11 U.S.C. § 507(a)(7).³ Conston agreed that it had an outstanding obligation to the IRS, but asserted that because the original tax claims were discharged in the first reorganization plan, Conston's obligations to the IRS stemming from the reorganization plan should be allowed in the present Chapter 11 only as general unsecured claims. D.I. 1, Exh. B. Relying on In re Benjamin Coal Co., 978 F.2d 823 (3d Cir.1992), the bankruptcy court agreed with Conston and held by order dated November 1, 1993, that "the claims filed by the Internal Revenue Service are disallowed except to the extent that the Internal Revenue Service is allowed a claim in the amount of $367,862.51 as a general unsecured claim." D.I. 1, Exh. E. Following the bankruptcy court's decision, the IRS appealed. D.I. 1. This Court has jurisdiction to hear the IRS's appeal pursuant to 28 U.S.C. § 158(a). The Court's review of questions of law is plenary. Brown v. Pennsylvania State Employees Credit Union, 851 F.2d 81, 84 (3d Cir.1988).

II. Stepping Back to View the Big Picture

Before turning to the specific issue presented in this appeal, it is beneficial to briefly survey the "big picture" under the Bankruptcy Code. Broadly speaking, when Congress enacted the Bankruptcy Code in 1978, it envisioned three remedies for a debtor who defaults on a non-fraudulent confirmed Chapter 11 reorganization plan: i) plan modification, including possible modification from a reorganizing to a liquidating plan, 11 U.S.C. § 1127(b) (permitting modification prior to substantial consummation of the confirmed plan); ii) conversion to Chapter 7, 11 U.S.C. §§ 1112(b)(7)-(8) (permitting conversion following default or failure to substantially consummate the reorganization plan); and iii) dismissal of the Chapter 11, id. (permitting dismissal following default or failure to substantially consummate the confirmed plan). Over time, debtors began to utilize a fourth option never envisioned by Congress but also not prohibited under the Code enacted by Congress — a second or serial Chapter 11 petition for relief, such as Conston has pursued in this case. Cf. Fruehauf Corp. v. Jartran, Inc. (In re Jartran, Inc.), 886 F.2d 859, 869 n. 12 (7th Cir.1989) (noting "the Code, legislative history and commentators to date simply do not consider the possibility of a situation in which a completely new liquidating Chapter 11 case could be used to deal with problems that arise in the course of consummation of a prior Chapter 11 plan").⁴

Within the pre-serial Chapter 11 universe of modification, conversion, and dismissal, the courts developed legal constructs to describe the practical implications of the discharge and confirmation concepts found in the Code. The general concept of discharge flows from § 1141, which provides "except as otherwise provided in this subsection, in the plan, or in the order confirming the plan, the confirmation of a plan ... discharges the debtor from any debt that arose before the date of such confirmation." 11 U.S.C. § 1141(d)(1)(A). The purpose of this section is to give the debtor a fresh start — "a new opportunity in life and a clear field for future effort, unhampered by the pressure and discouragement of preëxisting sic debt." Local Loan Co. v. Hunt, 292 U.S. 234, 244, 54 S.Ct. 695, 699, 78 L.Ed. 1230 (1934); accord Citizens Bank & Trust Co. v. Case (Matter of Case), 937 F.2d 1014, 1024 (5th Cir.1991); Owaski v. Jet Fla. Sys., Inc. (In re Jet Fla. Sys., Inc.), 883 F.2d 970, 972 (11th Cir.1989).

To put teeth into § 1141(d), the Code states that discharge voids any existing judgments against the debtor and "operates as an injunction against the commencement or continuation of an action, the employment of process, or an act, to collect, recover or offset any such debt as a personal liability of the debtor, whether or not discharge of such debt is waived." 11 U.S.C. §§ 524(a)(1)-(2); see also S.Rep. No. 989, 95th Cong., 2d Sess. 80 (1978), reprinted in 1978 U.S.C.C.A.N. 5787, 5866 (stating that discharge acts "as a total prohibition on debt collection actions").⁵ The § 524(a) discharge injunction operates into perpetuity to ensure the post-confirmation debtor receives the fresh start envisioned in § 1141(d)(1), and, "in effect, the discharge extinguishes the debt." Id. (emphasis added). The sanctuary of the discharge injunction is limited only as "provided in this subsection, in the plan, or in the order confirming the plan." 11 U.S.C. § 1141(d)(1).

In the pre-serial Chapter 11 universe of plan modification, conversion, or dismissal of a defaulting Chapter 11 plan, the courts borrowed the adjective "extinguished" to create a judicial gloss describing how discharge impairs a creditor's post-confirmation ability to enforce its pre-confirmation claim. When a court states that discharge "extinguishes" a debt, the judicial gloss implies, quite accurately, that the creditor can enforce only those pre-confirmation claims found in the confirmed plan and that the creditor can enforce those claims only in the manner and amount specified in the confirmed plan. From a commercial vantage point, the old debt is "extinguished," and a new debt is put in its place. Nevertheless, the courts have recognized the gloss on § 524 for what it is — a legal construct that describes a statutory effect — and plainly held that the statutory definition of discharge, by its own terms, does not cause the underlying debt to vanish. Johnson v. Home State Bank, 501 U.S. 78, 84, 111 S.Ct. 2150, 2154, 115 L.Ed.2d 66 (1991) (holding "the Court of Appeals thus erred in concluding that the discharge of petitioner's personal liability ... constituted the complete termination of the Bank's claim against petitioner. Rather, a bankruptcy discharge extinguishes only one mode of enforcing a claim — namely, an action against the debtor in personam"); Houston v. Edgeworth (Matter of Edgeworth), 993 F.2d 51, 53 (5th Cir.1993) ("A discharge in bankruptcy does not extinguish the debt itself.... Section 524(e) specifies that the debt still exists...."); Shure v. Vermont (In re Sure-Snap Corp.), 983 F.2d 1015, 1018, 1019 (11th Cir.1993) (holding that confirmation did not terminate debtor-creditor contract, and instead "prevented ... enforcing the terms of the Agreement ... to collect pre-confirmation debt," so that the discharged contract could therefore support award of attorney's fees incurred post-confirmation); Copeland v. Merrill...